Wall Street Reform Hits Main Street

A bill in the House threatens to impose a massive tax on America's most successful companies by subjecting them to bank-style regulation.

By

Gregory Zerzan

Updated Dec. 9, 2009 1:22 p.m. ET

This week the U.S. House of Representatives will vote on a bill purporting to address the causes of last year's market collapse. The "Wall Street Reform and Consumer Protection Act of 2009" aims to fix the problems that led to widespread and unprecedented government bailouts. One might expect such legislation to be focused mainly on the banks that were the nexus of the turmoil and recipients of so much taxpayer cash. But in reality the "Wall Street reform" bill isn't about them. Instead the bill threatens to impose a massive tax on America's most successful companies by subjecting them to bank-style regulation.

Consider the marquee aspect of the bill: creation of a "systemic risk regulator" to oversee companies that are so big and interconnected that their failure could endanger the entire economy. Addressing the danger that one company's default might bring down the whole system is a sensible one; after all, this threat was the justification for the Treasury handing out hundreds of billions of taxpayer dollars in TARP money. Of course, the reality of that threat remains unclear. Lehman Bros. was allowed to go bankrupt without any of its major counterparties doing likewise. AIG, on the other hand, was rescued and thus the possible impact of its bankruptcy will never be known. But in any case, it was clear that the crisis of '08 was a financial crisis—banks and trading firms were heavily leveraged and exposed to one another, and this interconnectedness brought with it the risk of a contagion effect.

Strange, then, that the legislation currently under consideration isn't limited to these firms. Instead it will apply to a whole host of companies engaged in routine, non-banking commerce.

The bill would give the systemic risk regulator sweeping authority over "financial companies," a term broadly defined to include any corporation involved "in whole or in part, directly or indirectly, in financial activities". In the world of banking regulation "financial activities" encompass more than taking deposits and making bank loans; they also include extending other forms of credit, holding assets in trust for another or guaranteeing against loss, all things thousands of American non-bank businesses do on a daily basis. Examples include a company that ships its product to a customer without demanding payment up front, holding money for its customers as a deposit for unfinished goods, or offering a revolving credit facility to a supplier.

"Financial activities" thus include ordinary commercial practices in corporate America, and not just what banks do. But any company engaged in these routine activities, even if just in part or indirectly, is potentially subject to an entirely new, costly regulatory regime. Any non-bank company that is identified by the government as too important to the economy immediately becomes subject to government inspection, supervision, and the requirement that it set aside capital in reserve based on decisions by regulators rather than businessmen. This means that the most successful American manufacturers and service providers would be forced to hoard cash instead of using it to employ Americans or develop new, innovative products.

For a company that the government views as too systemically important, there is no way out. The bill explicitly requires any non-bank "financial" company to submit to Federal Reserve and Federal Deposit Insurance Corporation regulation as if it were a bank holding company. This means that America's most successful companies will become subject to the same type of banking regulation that applied to many of the true financial institutions that were at the heart of the recent market crash.

Given that the bill is well over a thousand pages, it contains other proposals with far-reaching consequences as well. In the area of derivatives the legislation would require any company that uses the contracts, even purely to hedge its operational risks, to submit to regulation if its derivatives positions could expose the company's counterparties to "significant credit losses," as defined by the regulators.

The bill is not clear on exactly how many companies will end up becoming subject to these new regulations, but energy companies, large manufacturers and even some retailers are likely to fall into the mix. Among the other consequences, these companies will also be forced to put aside otherwise productive capital to appease regulators.

The legislation would bring entire sectors of the economy under federal regulation for the first time and mandate sweeping changes in how American businesses operate. Meanwhile, it does remarkably little to change banking regulation.

Under the guise of financial reform the so-called Wall Street reform legislation threatens to impose massive costs on many of America's best performing non-financial companies. With the economy still struggling and the unemployment rate hovering around 10%, diverting capital from hiring workers to paying regulatory costs seems like a counterintuitive approach to recovery. The proposed legislation doesn't really address Wall Street; instead its impact lands squarely on Main Street.

Mr. Zerzan was Acting Assistant Secretary and Deputy Assistant Secretary of the Treasury in the Administration of President George W. Bush.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.